Silicon Valley Bank Failure, FDIC and SIPC Insurance

(March 14, 2023) As a follow-up to the developing news on Silicon Valley Bank (SVB), we thought we would share some additional insight around questions we are hearing from clients related to FDIC insurance and the safety of their investment accounts at our custodians. If you did not have an opportunity to read our article on the SVB’s collapse that was sent out on Monday, you can find it here under the News + Intel section of our website.

What is FDIC insurance?

The Federal Deposit Insurers Corporation (FDIC) is an independent agency of the U.S. government that provides insurance to keep your money safe in the event of a bank failure. The FDIC insures up to $250,000 per depositor, per bank, for each account ownership category. Anyone with assets under that limit can rest assured that they are protected even if the bank fails. You can learn more information about the FDIC insurance coverage amounts on their website.

Note that the FDIC insurance thresholds apply for each account ownership category. As an example, a married couple is eligible for $500,000 protection on a joint bank account and $250,000 for each of their individual accounts, for a total of $1 million in coverage at a single bank. However, if an individual had only one savings account with $1 million at that same federally insured bank, that individual would be limited to $250,000 in FDIC coverage.

Is there similar protection for investments held at a brokerage firm, such as Fidelity or Schwab?

Yes. But before we explain, it’s important to understand the structural difference between a brokerage account, that holds stocks, bonds, mutual funds, etc., and a bank deposit account.

In the case of a bank account, your account balance is a contractual obligation of the bank. So, when a bank collapses, depositors with account balances above the FDIC insurance limit have the possibility of losing their deposits.

Brokerage firms hold investments on behalf of their customers. The investments in brokerage accounts are not owned by the brokerage firms and they legally must be segregated from the assets of the brokerage firms. So, if Fidelity or Schwab were to become insolvent, your investment accounts managed by Modera would not be at risk in the bankruptcy.

It’s helpful to think of this simple example: If I buy a share of stock in my Schwab account, Schwab executes the trade on my behalf, maintains records of my transactions, and provides me with market value information. Schwab handles the money for the transaction for a brief time while the trade settles, but ultimately the money for the stock purchase goes to the person/entity who sold the stock to me. Very simply stated, brokerage firms don’t hold the money in the same way that banks do. And, though your investments might fluctuate in value as they typically do as markets fluctuate, your account isn’t impacted by your broker-dealer’s financial situation. You are the owner of the securities in your account.

There have been numerous real-world examples of how the segregation of brokerage assets effectively protects investors. One notable brokerage failure was Lehman Brothers in 2008. When the firm failed, client brokerage accounts were transferred intact to a different custodian within days.

Brokerage accounts are covered by the Securities Investor Protection Corporation (SIPC).  SIPC is a non-profit member corporation made up of broker-dealers to protect investors’ assets should a brokerage firm declare bankruptcy or become insolvent. SIPC coverage protects cash and securities, up to $500,000 per customer for all accounts held at the same institution, with a maximum protection of $250,000 for cash. In addition, both Schwab and Fidelity maintain additional coverage in excess of SIPC limits with outside insurers. Schwab’s covers up to $150 million in securities and up to $1.15 million in cash per customer. Fidelity’s excess coverage does not have a per customer dollar limit on securities and has a $1.9 million limit per customer of coverage on cash awaiting investment.

For most investors, even those with large investment account balances, that amount is more than adequate because the regulatory framework requires broker-dealers to segregate customer securities from their own holdings, as explained above. SIPC coverage is intended to replace any securities not segregated by the broker dealer. This could arise from employee fraud or firm malfeasance.

What about cash and money market funds at a brokerage account? Is that protected as well by the FDIC or SIPC coverage?

Cash in brokerage accounts can be handled a couple of ways depending on the brokerage firm and the customer preference.

In some cases, cash is swept daily into money market funds. Just like other mutual fund investments, money market funds are owned by the end client and are segregated from the assets of the brokerage firm.

In other cases, cash balances are swept to a bank and are afforded FDIC protection. Cash balances above the FDIC limits can be distributed among multiple banks to increase the amount that can be insured by the FDIC.

Cash left in a brokerage firm account that is not swept to a bank or money market fund would fall under SIPC insurance protection. This could occur for a day or two while a trade is pending settlement. As a practical matter, most clients will rarely have significant cash sitting in their brokerage firms that would need protection from the SIPC.

Why did Schwab stock decline so much yesterday? Is the firm at risk?

The Charles Schwab Corporation (ticker SCHW) is both a bank and a brokerage firm. As a result of the recent bank failures, share prices of many banks suffered significant declines yesterday. This is a typical “throw out the baby with the bathwater” market reaction to bad news.

Based on information available, Schwab (as well as Fidelity) is well-capitalized and does not appear to be vulnerable to the types of risks that affected Silicon Valley Bank and others. Schwab Bank has a highly diversified depositor base and reported yesterday that 80% of its bank deposits were fully FDIC insured. (A preponderance of FDIC insured depositors makes a bank run significantly less likely. In contrast, only 15% of SVB’s deposits were fully insured when it failed.)

As always, we are here for you. Hearing the news in real time, especially news like this, can be disconcerting and, at times, confusing. While we never want to be reactionary, we also want to get in front of these issues so you, our clients, are well informed. Please reach out to us if you have additional questions.